Sept. 13 (Bloomberg) -- Under pressure from investors to fix the ailing McGraw-Hill Cos., Chief Executive Officer Harold “Terry” McGraw III disregarded his family’s legacy when deciding to break up the business founded by his great-grandfather in 1888.
“It’s not about me, it can’t be just about the family,” McGraw said in a phone interview yesterday after announcing a split of the company in two. “This is about a public company that is serving shareholders, employees and customers.”
McGraw, 63, has worked at McGraw-Hill since 1980, hired by his father, and has been CEO since 1998. Under his leadership, McGraw-Hill’s Standard & Poor’s unit grew from a remote outpost to the company’s most profitable business before drawing fire for its role in the 2008 financial crisis and last month’s downgrade of U.S. debt.
After losing 41 percent of its value since the end of 2006 and challenges from investors including Jana Partners LLC, McGraw-Hill said it would separate into two companies -- one focused on education, the other on financial ratings and data. McGraw will become CEO of McGraw-Hill Markets, effectively ending the family’s management of the textbook-publishing business.
“We’ve been in many configurations over those 123 years and we’re all thinking very hard about how we make these the greatest companies yet,” McGraw said. “If we get the customer part right and respond to those changes then everyone will be happy, family members too.”
Since 2005, revenue in the school education group has declined 27 percent. Jana Partners, in an Aug. 22 breakup proposal, called education a “drag” on the rest of McGraw-Hill.
The split means McGraw is placing his faith in S&P, where he first took the helm in 1988 and which has become a lightning rod for criticism.
S&P, along with Moody’s Investors Service, were blamed in an April U.S. Senate report for helping fuel the global financial crisis with inflated ratings for mortgage securities packaged during the housing boom.
“They were just vilified by everyone for their failure to see the risks in the mortgage-backed securities market,” said Joel Harris, managing director of HM Payson & Co. in Portland, Maine, which owns McGraw-Hill shares. “There’s been a lot of investor antagonism, frankly, for S&P.”
McGraw-Hill rose $1.24, or 3.1 percent, to $41.50 at 4 p.m. in New York Stock Exchange composite trading. The stock has declined 27 percent in the past five years, compared with a drop of 11 percent for the S&P 500 Index.
“Terry shares some disappointment that we missed on those ratings,” Chief Financial Officer Jack Callahan said in an interview. “There are places, like many leaders, where he wishes he could have one or two back in 2007 and 2008.”
McGraw attended Tufts University in Medford, Massachusetts, and received an MBA from the Wharton School of the University of Pennsylvania in Philadelphia. He worked for GTE Corp., now part of Verizon Communications Inc., before joining the family business.
He has taken the criticism of S&P seriously, and was instrumental in establishing an ombudsman empowered to take concerns about conflicts of interest to the CEO himself, said Winfried Bischoff, chairman of Lloyds Banking Group Plc in London, and a McGraw-Hill board member since 1999.
While the CEO always bears some responsibility, there was little McGraw could have done to ensure the accuracy of subprime mortgage ratings, Bischoff said.
“It became an industrywide phenomenon,” he said.
‘We Were Important’
When McGraw became head of the company’s financial services unit -- including the S&P business bought in 1966 -- it made up 28 percent of the parent company’s operating profit, the company said. Under his leadership, S&P increased its workforce and expanded overseas. In 2010 financial services accounted for two-thirds of that profit.
Old-timers, many of whom predated the purchase, viewed McGraw skeptically at the outset, said David Blitzer, chairman of the S&P index committee, who has worked for McGraw-Hill since 1980.
McGraw began to hold monthly meetings for S&P’s top 300 executives that included discussions about the future of the business and speakers such as then-New York Mayor Rudy Giuliani and Sandy Weill, who was Citigroup Inc.’s CEO, Blitzer said.
“The meetings were to give people a sense that S&P was important to McGraw-Hill and had real growth potential,” Blitzer said. “We were something, we were important, we were substantial, and were going to grow the business and make a lot of money.”
McGraw also jumped on a quiet corner of the business where he saw potential: the licensing of S&P’s indexes to mutual funds. The division has grown from indexing the 500 largest U.S. companies to more than 100,000 indices in markets globally. Goldman Sachs Group Inc. analyst Sloan Bohlen valued the business at $1.7 billion.
“It was clear from the first time I met him, here was someone clearly fascinated with money management and portfolio design and indices,” Blitzer said. “He said ‘There’s a lot of stuff here guys, let’s put it together and make it grow.’”
S&P’s index division grew to almost 300 employees from about 25 in the mid-1990s, he said. Without McGraw’s vision, “we wouldn’t be here today,” Blitzer said.
McGraw-Hill began publishing textbooks in 1927. The education business has struggled in the past five years as crimped budgets led states and school districts to spend less on materials.
The company has “consistently underperformed its potential,” Jana Partners said in its Aug. 22 breakup proposal.
As part of the split, McGraw-Hill said it will seek to cut corporate expenses and administrative and technology costs off a base of more than $1 billion, without specifying the extent of the reduction.
McGraw-Hill said it will accelerate the pace of its share buyback plan to $1 billion for the year, with $540.6 million repurchased year-to-date. The company will also begin searching for a CEO for McGraw-Hill Education, which expects to have revenue of about $2.4 billion this year.
In a joint statement yesterday, Jana and Ontario Teachers’ Pension Plan said they would review the proposed split. Together, they hold 5.6 percent, according to an Aug. 22 regulatory filing.
Investors to Review
“The separation, cost-cutting program and accelerated buyback will all be vital steps in reversing years of underperformance at McGraw-Hill, and are critical parts of what we were seeking for shareholders,” the investors said.
While Jana called for McGraw-Hill to be broken into four parts -- with S&P’s index business as one of them -- McGraw said two was the right number.
“This two-company approach will result in greater shareholder value with less risk and complexity than other approaches,” McGraw said yesterday on a conference call with investors.
Moody’s put McGraw-Hill’s A3 senior unsecured ratings on review for a possible downgrade, saying the spinoff of the education unit will involve a “significant portion of consolidated cash flow generation.” It also said it will review bondholder exposure to the risks of litigation and regulation associated with S&P.
In 2009, McGraw-Hill agreed to sell BusinessWeek magazine to Bloomberg LP, the parent of Bloomberg News.
The break-up plan “is an important first step in the right direction,” Peter Appert, an analyst for Piper Jaffray & Co., said in a note to investors. He called it “a pretty radical development for the traditionally staid/conservative McGraw-Hill.”
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